Capco Institute Blog

Last night, anyone with a TV set was able to watch the leadership of the Democratic Party celebrating what some call: “the most wide-ranging overhaul of U.S. financial regulations since the 1930's.” Everyone was applauding the President as he put pen to paper to bring into law a new era in consumer protection. As President Obama said: "The American people will never again be asked to foot the bill for Wall Street's mistakes. There will be no more taxpayer-funded bailouts. Period."

What I find fascinating about all this talk of protecting banking clients against the greedy bankers is that no one spent five minutes thinking about whether the new legislation would have in fact been any more effective in preventing or managing the recent crisis than what we already had. Would AIG have been allowed to go under if the Dodd-Frank Wall Street Reform and Consumer Protection Act was already in existence at the time it was announced that its failure could bring the entire financial system down? I somehow doubt that. Would the U.S. regulators have allowed Bear Stearns, Merrill Lynch, Citigroup, Goldman Sachs, and perhaps a few other big names whose sole saviour was the rescue of AIG and/or the unprecedented emergency financial support of the FED, to be slowly, but in a controlled manner, wound down so that U.S. taxpayers would not have to foot the bill to bail them out? I somehow doubt that too.

For all the showmanship on display on the U.S. Capitol Hill, the fact remains that the new law will be ignored if we go through a similar kind of crisis in the future. In fact, if anything, it might even be blamed for the next crisis, since it gave people a false sense of security.

Of course, many would argue that the new legislation is not only intended to ensure that we have controlled demolition of banks, it will also be very effective in preventing banks from pushing loans to people who cannot afford them. The new consumer protection agency will make sure that mortgages and other types of consumer loans will no longer get pushed onto unsavvy borrowers who cannot afford them, and they will certainly be protected from loans whose interest rates suddenly spike.

First of all, I doubt that everyone who took out a subprime mortgage was unaware that they could not repay them. Many took these loans since the property bubble allowed them to live the kinds of lives they could only dream of, in homes they could only dream of, without actually having to worry about repayments. They could, at least in theory, continuously cover their payments with new mortgages on the now more expensive home, and in fact have some cash left over to help further boost consumer spending.

As for other loans, or credit card debts, that go through a sudden spike in rates, well I can assure you that everyone I know who is complaining about that was fully aware that the spike will come. What they didn’t account for was that the opportunity to pay off one credit card debt with another zero interest one would one day come to an end and they would be stuck with a very large final debt, which has a huge rate attached to it. It always amazes me that people accuse banks of behaving badly by lending them money. I could never really work that one out. And, I will never forget an interview on British TV, about 3 years ago, with a man who claimed he felt violated and cheated by the banks that forced him to take out loans in excess of £50,000. He obviously did not feel violated when he was spending that money on holidays. I am still amazed that they even interviewed him as a victim of unscrupulous lending behaviour of banks.

I cannot talk about mortgages, and how they might have been pushed onto consumers in the U.S., but I can assure you that no one knocked on my friends’ doors asking them to get a credit card. And, if getting a letter through the post saying that you can get a credit card is pushing people to do things they would otherwise not have done, think to yourself how many purchases and investments you have made in response to such letters. Somehow people are more likely to become victims of taking money than giving it.

As for the Glass-Steagal light? Well, as I have stated many times before, we never had such a law in Europe and still did not face the kind of crisis that we have all just lived through. Separation of retail/commercial and investment banking, or more accurately prevention of proprietary trading, might make sense for a myriad of reasons, but it will certainly not prevent a similar crisis from happening again. What occurred during the current crisis was a perfect combination of events, with securitization and the destruction of due diligence that comes with it having a prominent role, that will only take place once in about 50 years or so. When we have all forgotten about the symptoms of the previous major crisis. And, when it comes around next time, we will still have to bail banks out. There cannot be a controlled closure of banks when the numbers we are dealing with are as large as the one in the current crisis.

In the U.K., I have personally witnessed two property bubbles, and in both cases none of the consumer protection ideas were able to help. When you see your neighbour suddenly becomes rich because he/she has started to invest in the property market with borrowed money and starts driving a Ferrari because their prices have risen sharply, even though his accent is no different to yours, you will do your utmost to also get on the bandwagon. And, no consumer protection agency will be able to stop you. Your bank is going through a similar challenge. When it sees that other banks are making a lot of money by lending to property speculators it will also want to join the bandwagon. When hysteria sets in, then no amount of discussion about economic fundamentals will be able to permeate through. Everyone suddenly believes that this time it will be different. The result is an economic miracle, with many people feeling very rich, and the government taking credit for it. Now, you tell me, would President Obama force the FED to burst the property bubble at that stage or stop people finding ways to take out mortgages they really can’t afford to repay simply because he wants to avoid having to bail the banks out when the inevitable correction comes? Somehow, I doubt that too.